Swedroe: Using Factors To Weather Storms

How do size and value tilts help investors get through recessions safely?

Earlier this week, we examined how domestic stocks, in general, perform during recessions. Today we’ll take a look at how the size and value premiums performed in 12 recessions, identified as such by the National Bureau of Economic Research, occurring in the post-World War II era. During that period, the average length of a recession was 11 months.

Size Premium

• While the size premium from 1926 through 2013 was 3.1 percent, during the 12 recessions since 1945, the average size premium was close to zero, at just 0.5 percent (total return).
• The size premium was positive in seven of the 12 recessions.
• The largest size premium occurred during the most recent recession, which began in December 2007 and ended in June 2009, when the premium was 12.1 percent.
• The most negative size premium occurred in the recession that began in December 1969 and ended in November 1970. During that period, the size premium was negative 16.4 percent.

Value Premium

• While the value premium from 1926 through 2013 was 4.9 percent, during the 12 recessions since 1945, the average value premium was 3.3 percent.
• The value premium was positive in just five of the 12 recessions.
• The largest value premium occurred during the recession that began in November 1973 and ended in March 1975. However, there were two other recessions, occurring from December 1969 to November 1970, and July 1981 to November 1982, when the value premium was in excess of 18 percent.
• The most negative value premium occurred in the recession that began in November 1948 and ended in October 1949.

Because the stock market is a leading indicator, it might also be instructive to look at the how the size and value factors performed in the six months prior to each recession.

‘Size’ Up Close

We’ll begin by examining the size factor. In the six months prior to the 12 recessions, the size factor produced an average premium of 0.32 percent. Thus—on average—even in the six months leading up to a recession, the return on the factor was still in positive territory. However, it was still well below its annual average of 3.1 percent.

In addition, the return on the factor was negative in eight of the 12 periods. The worst performance was in the six months prior to the recession that began in December 2007, when the size factor was a negative 6.9 percent. The best performance was during the six months prior to the recession that began in July of 1981, when it was 12.4 percent. If we look at the results for the three months prior to a recession, we find that there was an average size premium of 1.16 percent, and it was positive seven of the 12 periods.

‘Value’ Up Close

Turning to the value factor, in the six months prior to the 12 recessions, the value factor produced an average premium of 2.3 percent. That’s about half of its annual average return of 4.9 percent. And it was positive in seven of the 12 periods. The worst performance was in the six months prior to the recession that began in December 2007, when the value factor was negative 11.1 percent.

The best performance was during the six months prior to the recession that began in March 2001, when the value factor was 43.5 percent. If we look at the results for the three months prior to a recession, we find that there was an average value premium of 0.3 percent, and it was positive in five of the 12 periods.

The bottom line is that, even if you had a perfectly clear crystal ball to tell you when recessions would start and end, there doesn’t seem to be any advantage in using that information to implement a tactical asset allocation strategy shifting from riskier small and value stocks to safer large and growth stocks during such periods.

The reason is simply that, even though the small and value premiums have been smaller than their averages during recessions, they have still existed.

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.